Snapshot Notes - November 12, 2007

As of:

SPX 1457

Earlier this afternoon, I went over the reasons why it was difficult for me to turn too negative in spite of the recent selling pressure. During the modern market's history, when we've seen these kinds of technical conditions in the past, it has generated positive returns in the intermediate-term about 90% of the time.

Some of those technical conditions are becoming quite shaky, though, in particular when looking at the S&P 500. That index is in a perilous condition, and we need to see some buying pressure emerge soon or the game will be changing significantly.

The case can be made that that buying pressure should come very soon, like tomorrow. "Turnaround Tuesday" is a popular phrase on Wall Street, referring to the idea that the markets often rebound in the short-term after a bad Monday. There is truth to that theory, especially coming after a bad week the week before.

Since 1950, the S&P has dropped more than 1% on a Monday, after losing more than 4% the week before, on 22 occasions. Over the next two days, the index showed a positive return 17 of those times, by an average of +2.3%.

With the performance we've seen the past few days, it's not hard to make the case that we're oversold. Now we just need to see that actually matter, and manifest itself in prices that don't set new intraday lows every single day. I do like the idea that we're setting up for a rebound, but I don't want to lean too heavily on that idea until we see prices begin to stabilize. We had a great chance for that on Friday, until the last hour blew that apart. Now we need to see some kind of similar reversal or basing action in order for me to step up more, otherwise I'll have to abandon the idea that this high-probability trade setup is going to gain any traction.

As of:

SPX 1457

HELP ARCHIVE

The main reason I've been looking for the potential for a longer-than-short-term trade over the next week or two is a combination of three things:

Each of those components can be defined any number of ways, and we could probably data-mine them to create either fantastic results or horrible ones. Well, maybe not so much the latter, but certainly the former.

In order to avoid the data-mining bias as much as possible (in which we turn computers loose looking for patterns, which they are bound to find, but which are likely completely worthless), I tend to use the same parameters for indicators over and over. Instead of using, say, a 153-day moving average to define "trend", I use a 200-day average, even if using a 153-day average would optimize the results.

I keep going back to the fact that when we've seen these three parameters come together, equities have been consistently positive going forward. Just as an example, I checked for any time that the 3-day Relative Strength Index (RSI) for the S&P 500 crossed under 15 during November, while the 200-day moving average was rising (this happened on Friday).

Buying then and holding for two months (taking us through mid-January of the following year on average) resulted in 25 positive results out of 28 tries, with an overall average return of +5.2%. The average drawdown (i.e. maximum loss) of -1.9% was significantly less than the average maximum gain of +6.8%. The last losing trade was more than 45 years ago, in 1961.

Obviously we can see anything at any time, but I have found these types of tendencies to be tremendously helpful over the years, and it's why I have a difficult time turning bearish here despite what is becoming a questionable trend in the S&P 500.

For now, I'm going to keep giving that index, and equities in general, the benefit of the doubt here, but I really want to see some price stabilization before becoming aggressive with the idea that the "oversold in an uptrend" bounce is going to take hold. I'd prefer to see an intraday or consecutive-day rebound (that sticks for more than an hour!) to step up a bit more. With the historical tendency for markets to bounce back on Tuesday after a weak Monday (especially when that comes on the heels of a big sell-off the week before), and the generally positive bias during option expiration weeks, we should really be seeing the bulls take a stand over the next couple of days.

As of:

SPX 1457

HELP ARCHIVE

Good Monday morning...we begin the next week with some very choppy trading in the major indices. Overnight futures had taken a big dip, but we recovered early once regular trading began, then reversed again to test the morning low. With bond markets mostly closed, we may see lower volume and choppier trading anyway. Sector-wise, financials continue to make good on their bottoming attempt, though it's curiously not having much of an impact on the broader market.

During mid-week last week, we went over a few things that suggested that although there could/should be some additional short-term pain ahead of us, some things were lining up for a trade-able bounce in the financials and broader market, the type of rally that should last for weeks.

Friday afternoon's upside reversal seemed to seal the deal for at least a short-term respite from the selling pressure, but then the last hour hit and things went haywire, throwing those thoughts of a reversal in the trash bin.

I mentioned after the close Friday that I frankly didn't have much of a clue as to what that last hour may portend, and I still don't. The data released over the weekend was mixed in terms of its potential impact on the broader market. Short sales data shows that the public had been shorting very heavily near the end of last month, which tends to be a good intermediate-term contrary indicator, but small-trader options data from last week shows that those traders haven't let up a whole lot from the excessive bullish bets we went over in a longer-term comment earlier this month.

Seasonality into the beginning of next year is generally positive, and will become even more so heading into next week. The major indices are mixed in terms of technical position, with the S&P 500 in a very questionable position. It has formed a series of lower highs and lower lows over the past month, the 50-day moving average is sloping downward and the 200-day is threatening to do the same. There are thousands of complicated models that try to define "trend', but those simple ones work just as well as any of them.

So at this point, we have a questionable trend and seasonality that is OK but not quite to the point where I would consider it absolutely positive. Sentiment-wise, we have a pretty good collection of oversold extremes, as listed on the "Indicators at Extremes" section of the Daily Overview page, but our more intermediate-term models haven't had enough time to reflect many of those. In the short-term, most of our stuff is at least moderately oversold, but with a questionable trend and seasonality, I'm not pressing aggressively on the long side unless we see some kind of price stabilization. Hitting new lows every day is not the kind of thing I want to keep seeing.

Forwarding or otherwise distributing this copyrighted material is a breach of your subscriber agreement. Violators are subject to termination of their subscription with any received subscription fees forfeited. Any references to historical performance are based on data we deem to be reliable, but are based upon feeds from third parties. We do not recommend subscribers take positions based on data presented here alone, but rather incorporate it into a comprehensive investment outlook.